Investing in the banking sector can be profitable, but there are many facets you should be aware of before putting your money in the market. There is investment banking, consumer banking, and commercial banking. Each with their own unique qualities, they offer a wide spectrum of exposure and bring with it a variety of risks as well. Understanding what your portfolio needs and what can affect each investment will prepare you for what the market has to offer.
Investment banking is exactly what it sounds like, banks that invest money for their clients or invest in their clients. Notable names include Goldman Sachs and UBS, which are global and intertwined in the financial system. Companies in this category can offer big banking exposure to a portfolio.
Items to keep in mind include global climate, interest rate changes, and trade. In the United States, it is a rising interest rate environment leading to higher returns on Certificates of Deposit and money market funds. There are drawdowns as it is more expensive for investment banks to lend. The large institutions have exposure to world markets so staying privy of financial happenings is a must.
This sector of the banking world will be exposed to mortgages, automotive loans, and credit cards. Typically much smaller than investment banks, consumer banking can be national or regional. Attention to consumer sentiment numbers and job reports in the United States are important as it is an indicator on how individuals are spending.
Consumer banks make most of their money off interest on loans. In a rising interest rate environment, it will benefit the consumer banks but make it more expensive for the individual to borrow. This means 30-year and 15-year mortgages will cost more and may disincentives people from purchasing homes. Consumer banking follows the market cycle and should be properly hedged.
Lastly, there is commercial banking and this includes business lending and commercial real estate. A mixture of investment banking and consumer banking, there are exposures to interest rates and global economics. Small banks will lend to small businesses while larger banks may lend to national businesses with many employees and properties.
There are only a few ways to gain exposure, and that is through banks, investment banks, or REIT’s, which are real estate investment trusts. Other areas to consider include corporate bonds and municipal bonds. Risks include rising interest rates, global economic conditions, as well as the market cycle. Banks may not lend or restrict lending if they fear markets will slow.
The banking sector offers a variety of investment opportunities, but brings with it the need for due diligence. Banking is subject to the market cycle and tends to be on the volatile side. With exchange traded funds and options, there are many ways to hedge your positions. Each bank has much to offer, but fundamental analysis and a solid credit rating is a must. Also, reviewing monthly and quarterly numbers will give you a report to guide your research.